This case arises out of one of the largest bank failures in United States history. In August 2009, in the wake of the financial and housing crises, Guaranty Bank’s parent company filed for bankruptcy. Plaintiffs represent a putative class of former Guaranty stockholders whose equity interests were wiped out when Guaranty failed. They bring federal securities law claims against four former Guaranty executives, alleging that the executives made materially false and misleading statements regarding Guaranty’s assets. The district court dismissed the claims. For the following reasons, we AFFIRM.
FACTS AND PROCEEDINGS
Temple-Inland, Inc. (“Temple”) was a holding company that operated a packaging and manufacturing business and a financial services business, Guaranty Financial Group Inc., (“GFG”) which, in turn, owned Guaranty Bank (the “Bank”).
Temple’s concerns over Guaranty’s solvency stemmed from the composition of Guaranty’s asset portfolio. Guaranty had purchased investments in residential mortgage-backed securities (“MBS”), which are created by pooling mortgage loans into a trust. Guaranty’s portfolio contained a significant amount of “non-agency” MBS— those issued by private institutions rather than government-sponsored entities. Non-agency MBS are generally understood to have higher returns and higher risks than their government-sponsored counterparts. Plaintiffs allege that Guaranty’s non-agency MBS portfolio always constituted at least 22% of Guaranty’s total assets. Further, plaintiffs allege that a substantial portion of Guaranty’s MBS was collateralized by risky adjustable rate mortgages. On the other hand, none of Guaranty’s MBS contained subprime mortgages. Guaranty also did not invest in the most junior tranches, or levels, of MBS, meaning that losses would not affect Guar
Defendants Kenneth M. Jastrow, Kenneth R. Dubuque, Ronald D. Murff, and Craig E. Gifford were all high-level executives in Guaranty and, in some cases, Temple. Plaintiffs claim that after the spin-off, Guaranty, led by defendants, violated Generally Accepted Accounting Principles (“GAAP”) by systematically overvaluing its MBS portfolio and undervaluing its losses. Defendants allegedly compounded this problem by failing to properly record Guaranty’s losses as “other than temporary impairment” (“OTTI”). Defendants reported these allegedly erroneous accounting figures in public filings. Plaintiffs claim that defendants were motivated by the knowledge that, absent fraud, Guaranty’s regulatory capital would have been inadequate and Guaranty would not have had time to procure capital necessary to continue as a going concern.
For a time, Guaranty was successful in masking its financial difficulties; it attracted capital infusions in 2008. But Guaranty’s health continued to decline. In July 2009, Guaranty announced that, at the direction of the Office of Thrift Supervision (“OTS”), Guaranty had amended its Thrift Financial Report for the period ending March 31, 2009 and recorded a $1.62 billion impairment on its MBS portfolio. Soon after, the OTS closed Guaranty and the Federal Deposit Insurance Corporation (“FDIC”) was appointed as receiver. GFG filed for bankruptcy protection on August 27, 2009.
On August 22, 2011, Guaranty’s bankruptcy trustee, Kenneth L. Tepper, sued Temple and various other defendants, including Jastrow and Dubuque, alleging that they had raided over $1 billion in assets from Guaranty.
Plaintiffs initially filed this putative class action on November 11, 2011. They filed an amended class action complaint on April 19, 2012 on behalf of all purchasers of GFG common stock between December 12, 2007 and August 24, 2009 (the “Class Period”), against Temple and the individual defendants. Temple and the individual defendants moved to dismiss the amended complaint. The district court granted the motions on several grounds, including the failure to adequately allege defendants’ scienter. The district court granted plaintiffs leave to amend, however, and plaintiffs filed the Second Amended Complaint (“SAC”), which alleged claims against the individual defendants alone. The individual defendants again moved to dismiss. The district court found that the SAC did not adequately allege scienter, and granted the motions, dismissing the case with prejudice. Plaintiffs timely appealed.
DISCUSSION
I. Standard of Review
The SAC alleges violations of Section 10(b) of the Securities Exchange Act of 1934,15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5. Plaintiffs also allege control
We review a district court’s dismissal of federal securities law claims under Rule 12(b)(6) de novo. Flaherty & Crumrine Preferred Income Fund, Inc. v. TXU Corp.,
Pursuant to Federal Rule of Civil Procedure 9(b), plaintiffs must state all allegations of fraud with particularity by identifying the “time, place, and contents of the false representations, as well as the identity of the person making the misrepresentation and what that person obtained thereby.” Tuchman v. DSC Commc’ns Corp.,
Plaintiffs allege that defendants made an array of materially false and misleading statements in SEC filings and public comments throughout the Class Period. Defendants allegedly violated GAAP and SEC rules by (1) reporting overstated MBS values, and understated losses, stemming from the use of flawed internal asset pricing models; and (2) failing to timely record OTTI in the portfolio.
II. Scienter
The central issue in this case is whether the SAC contains sufficient facts to allege scienter as to each defendant. The district court dismissed the SAC on the ground that it did not.
The PSLRA imposes heightened pleading standards on private plaintiffs bringing actions pursuant to Section 10(b) and Rule 10b-5. See 15 U.S.C. § 78u-4; Tellabs, Inc. v. Makor Issues & Rights, Ltd.,
Severe recklessness is limited to those highly unreasonable omissions or misrepresentations that involve not merely simple or even inexcusable negligence, but an extreme departure from the standard of ordinary care, and that present a danger of misleading buyers or sellers which is either known to the defendant or is so obvious that the defendant must have been aware of it.
Abrams v. Baker Hughes Inc.,
To withstand a 12(b)(6) motion to dismiss, the required “strong inference” of severe recklessness must be “more than merely ‘reasonable’ or ‘permissible’—it must be cogent and compelling, thus strong in light of other explanations.” Tel-labs,
A. Threshold issues
Plaintiffs and defendants each raise one issue that they contend warrants reversal or affirmance, respectively, without requiring consideration of the specific scienter allegations.
i. Holistic review
Plaintiffs contend that the district court’s scienter analysis was flawed because the district court evaluated the scienter allegations individually rather than collectively. When analyzing a complaint for scienter, a court must “assess all the allegations holistically,” not in isolation. Tellabs,
Plaintiffs raise two points in support of their argument. First, plaintiffs contend that the district court’s two-step method of first assessing the allegations individually, before weighing them collectively, violates Tellabs’s prescription. In support, they- cite the Sixth Circuit’s decision in Frank v. Dana Corp.,
Our former method of reviewing each' allegation individually before reviewing them holistically risks losing the forest for the trees. Furthermore, after Tel-labs, conducting an individual review of myriad allegations is an unnecessary inefficiency. Consequently, we will address the Plaintiffs’ claims holistically.
Id. Contrary to plaintiffs’ suggestion, Frank does not stand for the proposition that Tellabs forbids the method of first reviewing each allegation individually; rather, Frank advises . against such a method because, in the view of that court, it is “an unnecessary inefficiency.” Id. Moreover, this court, after Tellabs, has endorsed the district court’s two-step method. See Central Laborers’ Pension Fund v. Integrated Elec. Servs. Inc.,
Second, plaintiffs argue that, even if the two-step method is permissible, the district court did not, as it said, view “the [SAC’s] allegations as a whole.” Plaintiffs point to numerous instances where the district court stated that a particular allegation did not “alone” contribute to a strong inference of scienter.. The district court did not err in stating, throughout its inquiry, that various allegations, standing alone, did not constitute a strong inference of scienter. As a matter of efficiency, if any single allegation, standing alone, created a strong inference of scienter, the court would not need to consider additional allegations of scienter. After analyzing each allegation alone, the district court properly proceeded to the second step and determined that the allegations, as a whole, did not raise a strong inference of scienter as to each defendant. See Shaw,
ii. Group' pleading
Defendants complain that the SAC contains impermissible group pleading. This court has rejected the group pleading doctrine. See Southland,
Defendants disagree among themselves about the proper remedy for this deficiency in the SAC. Defendants Jastrow and Dubuque contend that group pleading' and the related problem of puzzle pleading—where a court must wade through a complaint and pick out properly pleaded segments—warrants dismissal of the entire SAC.' Defendants Murff and Gifford
B. Allegations common to more than one defendant
We now discuss the allegations that, according to plaintiffs, lead to a strong inference of scienter. First, we look at the various allegations that apply to more than one defendant and discuss the appropriate inference, if any, to be drawn from them.
i. Knowledge of undercapitalization and motive
One of plaintiffs’ primary allegations is that defendants had knowledge of Guaranty’s undercapitalization
The SAC pleads with particularity that defendants Jastrow, Dubuque, and Murff — but not Gifford — knew of Guaranty’s undercapitalization. The SAC alleges that Dubuque met with Temple’s management before the spin-off and suggested that Guaranty needed $200 million in additional capital. Dubuque is also alleged to have had discussions after the spin-off in which he expressed the desire for $100 million in additional capital. Dubuque and Murff are alleged to have led a meeting in
The resulting question is whether any inference of scienter should be drawn from defendants’ knowledge of Guaranty’s undercapitalization. The desire to raise capital in the normal course of business does not support a strong inference of scienter because virtually all corporate insiders share this goal. See Abrams,
“[Appropriate allegations of motive and opportunity may meaningfully enhance the strength of the inference of scienter, but ... allegations of motive and opportunity, without more, will not fulfill the pleading requirements of the PSLRA.” Goldstein v. MCI WorldCom,
Plaintiffs maintain that this case is similar to Nathenson v. Zonagen Inc.,
The motive allegations contribute to a finding of scienter as to Jastrow, Dubuque, and Murff, but must be considered together with other allegations to determine if they rise to a strong inference of scienter.
ii. Knowledge of red flags regarding MBS valuation
Plaintiffs allege that Guaranty’s MBS valuation and its decision not to recognize losses as “other than temporary” violated GAAP. Because the question of whether the statements actually violated GAAP is fact-dependent, it is not properly - addressed on a motion to dismiss. See Barrie v. Intervoice-Brite, Inc.,
Plaintiffs contend that several “red flags” included in the SAC should have alerted each defendant that the MBS valuation was materially incorrect. The red flags include (1) a 250% increase in the average delinquency rate on Guaranty’s non-agency MBS portfolio in the nine-month period ending June 30, 2008; (2) a decrease in the value of the non-agency MBS portfolio to 60% of its cost by June 30, 2008; and (3) the downgrading or placing on negative watch of ten securities in Guaranty’s portfolio in June and July 2008.
The “red flags” add little inference of scienter. Each “red flag” is alleged to have become knowable only in June 2008, whereas many of the alleged misrepresentations occurred before June 2008. Even as to those alleged misstatements that occurred after the “red flags” were apparent, the red flags were disclosed to the public, which negates the inference that defendants acted with scien-ter. See Fire & Police Pension Ass’n of Colo. v. Simon,
Additional transparency, not disputed by plaintiffs, further negates the inference of scienter. Defendants disclosed that Guaranty’s MBS valuation was based on internal models, not market prices, and Guaranty disclosed the inputs it used in its models. Guaranty provided investors with additional explanatory and cautionary information from which they could judge the accuracy of the models and Guaranty’s decision not to recognize losses as other than temporary. Guaranty’s filings further disclosed that valuation was “difficult,” and that the valuation estimates involved a “high degree of uncertainty” and might “prove to be materially incorrect.” As the Supreme Court recently recognized, “an investor reads each statement within [an SEC document], whether of fact or of opinion, in light of all its surrounding text, including hedges, disclaimers,, and apparently conflicting information.” Omnicare, Inc. v. Laborers Dist. Council Constr. Indus. Pension Fund, — U.S. -,
We distinguish this case from Spitzberg v. Houston American Energy Corporation,
Defendants’ disclosure of the “red flags” and candidness about the uncertainty underlying its models neutralize any scienter inference from “red flags.”
iii. Magnitude of alleged misstatements
Plaintiffs contend that the magnitude of the valuation errors contributes to a strong inference of scienter. The significance of a large accounting error depends on the circumstances. In Goldstein, we held that a $685 million write-off did not create a strong inference of scienter because the company was large and frequently took similarly-sized write-offs.
Having discussed the underpinnings and merits of the common allegations regarding scienter, we proceed to a holistic review, for each defendant, of all scienter allegations applicable to that defendant.
i. Dubuque and Murff
Dubuque was President, CEO, and a director of Guaranty until his resignation on November 19, 2008. He was also Guaranty’s Chairman from August 26, 2008 until his resignation. Murff was Senior Executive Vice President and Chief Financial Officer of Guaranty until his resignation on July 10, 2009. From October 27, 2008 until his resignation, Murff was also Guaranty’s Principal Accounting Officer. Plaintiffs seek to hold Dubuque and Murff liable for their conduct throughout the Class Period, including statements made in Guaranty’s 2007 10-K, 2008 10-Qs, and several other statements made between February 2008 and November 2008.
As discussed, supra, the SAC alleges that Dubuque and Murff knew of Guaranty’s undercapitalization and had a motive to falsify the MBS valuation to raise additional capital. However, because knowledge and motive alone are insufficient to raise a “strong inference” of scienter, Goldstein,
In addition to the knowledge allegations, the SAC alleges that Dubuque and Murff were aware of internal warnings regarding the MBS valuation. These allegations revolve around a confidential witness, designated in the SAC as CW1, who was responsible for purchasing MBS as Guaranty’s Senior Vice President of Investments and Secretary of the Asset Liability. Committee (“ALCO”).
Dubuque’s and Murffs continued reliance on Guaranty’s internal valuation model and unchanged OTTI determinations, after CWl’s warnings, does not lead to a strong inference of scienter. That the reported figures are alleged to have violated GAAP is not, by itself, actionable. See Shaw,
An inference of severe recklessness is more likely when a statement violates an objective rule than when GAAP permits a range of acceptable outcomes. See In re MicroStrategy, Inc. Sec. Litig.,
While recognizing that some GAAP concepts may allow for subjective judgments, plaintiffs argue that defendants’ MBS valuation and decision not to recognize an OTTI were governed by objective standards. Specifically, plaintiffs argue that defendants violated an objective GAAP directive requiring that OTTI be assessed “at the individual security level” by failing to “drill down” and assess OTTI at the individual loan level. Plaintiffs misapprehend this GAAP requirement. In determining whether to recognize an OTTI, GAAP does not require a company to assess the likelihood of repayment of each of thousands of loans in each security.
Although plaintiffs argue that Dubuque and Murff were “repeatedly” made aware of the deficiencies in Guaranty’s models, the email from CW1 is the only warning alleged to have been conveyed to Dubuque and Murff. CWl’s warnings did not mention GAAP and do not seem to suggest that any issues were so severe that they could lead to a large overvaluation of the MBS portfolio.
Dubuque and Murff relied on outside ratings agencies, which rated all of Guaranty’s MBS AAA until June 2008. We find that reliance on AAA ratings, when CW1 did not caution that reliance on major outside ratings agencies was unwarranted, was not severely reckless. FASB guidance explicitly instructs companies to consider a security’s credit rating when deciding whether to recognize a loss as other than temporary. Moreover, defendants were not alone in relying on AAA ratings in the face of potential red flags. OTS, Guaranty’s regulator, similarly failed to recognize risks associated with Guaranty’s MBS portfolio “primarily because the nonagency MBSs that Guaranty bought were graded AAA by credit rating agencies.” OTS’s report on Guaranty’s demise found that: “From 2004 through 2007, both [Guaranty] and OTS relied on the AAA ratings and considered the risk of purchasing AAA-rated nonagency MBSs to be minimal.” At the time of CWl’s warnings in 2007, both Guaranty and its federal regulator viewed the AAA ratings to be a crucial factor in the MBS portfolio’s valuation.
We find persuasive the Second Circuit’s discussion of very similar allegations in City of Pontiac Policemen’s and Firemen’s Retirement System v. UBS AG,
While the collapse in the entire sub-prime market revealed UBS’s failure to recognize the vulnerability of all its mortgage-related assets to have been poor judgment, poor business judgment — even if attributable to monetary incentives — does not establish an inference of recklessness that is cogent andcompelling [and] thus strong in light of other explanations. We do not recognize allegations of fraud by hindsight.
Id. at 187-88 (internal quotation marks and citations omitted). Here, plaintiffs’ allegations similarly combine poor business judgment with financial motive. See Abrams,
Considered holistically, plaintiffs’ allegations of knowledge of Guaranty’s underca-pitalization, a large misstatement, red flags, and ignorance of internal warnings, do not raise a strong inference of severe recklessness that is equally as likely as the competing inference that Dubuque and Murff negligently relied on the AAA ratings and believed that Guaranty’s internal models were accurate. Plaintiffs come closest to alleging scienter by noting that Dubuque and Murff continued to use the internal models even after the ratings agencies downgraded or placed some of Guaranty’s MBS on negative watch. But the SAC contains no particularized allegations of renewed warnings to Dubuque and Murff in the 18 months between CWl’s January 2007 email and the earliest downgrades in June 2008. It is also undisputed that Guaranty never purchased the most junior tranche of MBS, meaning that there was a buffer before losses would begin to affect its portfolio. See Blackwell,
ii. Jastrow
Jastrow was the CEO and Chairman of the Board of Directors of Temple until the spin-off, and was Chairman of the Board of Directors of Guaranty until his resignation on August 26, 2008. Plaintiffs seek to hold Jastrow liable for wrongful conduct from the beginning of the Class Period through his resignation. Plaintiffs identify two alleged misstatements made by Jastrow. First, Jastrow signed a cover letter to a Form 8-K filed with the SEC in December 2007, just prior to the spin-off. The Form 8-K contained a statement that financial disclosures were based on GAAP. Second, Jastrow signed a Form 10-K issued by Guaranty on February 29, 2008. Plaintiffs contend that the 10-K’s statement that its financial statements conformed with GAAP was materially false.
The SAC did not allege that Jas-trow was ever informed of internal disagreements or warnings regarding Guaranty’s MBS valuation. Plaintiffs do not allege that he received any communications from any of the confidential witnesses. • The “red flags” highlighted in the SAC are not alleged to have alerted any
The only additional allegation as to Jas-trow does not provide the missing piece. The SAC alleges that, at a Temple board meeting, Jastrow stated that the California real estate markets were deteriorating because adjustable rate mortgages were being reset.
iii. Gifford
Gifford was Guaranty’s Controller until December 2007 and was Guaranty’s Executive Vice President and Principal Accounting Officer from December 2007 until his resignation on October 27, 2008. Plaintiffs seek to hold Gifford liable for wrongful conduct from the beginning of the Class Period through his resignation. Plaintiffs identify three alleged misstatements made by Gifford. Gifford signed Guaranty’s 2007 10-K and two 10-Qs, filed on April 29, 2008 and August 11, 2008, all of which allegedly included the misrepresentation that the financial statements contained therein complied with GAAP.
The case for Gifford’s scienter is the weakest of any defendant. Gifford was not a party to the Tepper action, nor are there any other allegations that he was aware of Guaranty’s undercapitalization at any point during the Class Period. The SAC does not allege that Gifford was privy to any concerns about deficiencies in Guaranty’s internal valuation models.
Essentially, the SAC alleges only that Gifford held the position of Principal Accounting Officer at the time a large misstatement was made, and that red flags existed. We have already discussed why the magnitude of the misstatement and red flags do not create a strong inference of scienter, and Gifford’s position within Guaranty does not support a strong inference of scienter. “A pleading of scienter may not rest on the inference that defendants must have been aware of the misstatement based on their positions within the company.” Abrams,
III. Other issues
Because of our conclusion that plaintiffs have not raised a strong inference of scien-ter as to any defendant that is “at least as compelling as any opposing inference of nonfraudulent intent,” Tellabs,
CONCLUSION
Our holistic review of the Second Amended Complaint confirms that plaintiffs have failed to adequately plead facts that raise a strong inference of scienter. Accordingly, we AFFIRM the district court’s dismissal of this action.
Notes
. This opinion uses the general term "Guaranty” when no distinction between GFG and the Bank is warranted.
. Complaint, Tepper v. Temple-Inland, Inc., No. 3:11-cv-02088,
. We are also wary that a strict rule requiring outright dismissal for any group or puzzle pleading could cause future plaintiffs to omit from complaints helpful information about the activities of a non-party or contextual statements about defendants that may not be able to be particularized.
. These allegations do not constitute group pleading because they are sufficiently particularized. However, because they apply to more than one defendant, they are most easily discussed together.
.The SAC's use of the term "undercapital-ized” likely refers to the industry-specific definition of regulatory capital, see 12 C.F.R. § 325.103 (defining the risk-based capital ratios that constitute a bank’s undercapitalization), and not the colloquial definition, see Black’s Law Dictionary 251 (10th ed.2014) (defining “undercapitalization” as “[t]he financial condition of a firm that does not have enough capital to carry on its business”). Regardless, this distinction is not significant for our discussion of scienter.
. The parties do not dispute that we should consider the Tepper complaint’s allegations regarding knowledge of undercapitalization because they were expressly incorporated by the SAC. See Stratte-McClure v. Morgan Stanley,
. Plaintiffs argue that the SAC alleges Gif-ford’s knowledge of undercapitalization because, due to his position as Guaranty's Principal Accounting Officer, he "cannot credibly claim ignorance of [Guaranty's] financial situation.” This allegation is not contained within the SAC and, in any event, is not pled with particularity. We therefore decline to infer that Gifford had knowledge of Guaranty’s un-dercapitalization.
. We decline to draw additional inferences of scienter from the Tepper action. Because the Tepper complaint covers only events before the Class Period, it does not directly address the misstatements at the heart of this case. For this reason, and because the persuasive force of the Tepper action's settlement is disputed, we limit the contribution to scienter of the Tepper complaint to Jastrow’s, Dubuque’s, and Murff’s knowledge of Guaranty's under-capitalization.
. Before the district court, plaintiffs argued that the timing of each defendant’s resignation suggested scienter. The district court concluded that Guaranty's overall decline, rather than securities fraud, was likely the impetus for the resignations. The district court also concluded that defendants’ signatures on Sarbanes-Oxley certifications did not lead to scienter absent the signer's knowledge of the underlying falsity or severe recklessness in recognizing it. See Garfield v. NDC Health Corp.,
. We discuss Dubuque and Murff together because the allegations involving each largely overlap.
. In cases under the PSLRA, plaintiffs may rely on confidential witnesses "provided they are described in the complaint with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged.” Tchuruk,
. The district court discounted CWl's email because it occurred before the Class Period. Knowledge gained before the Class Period may be retained months later and there is no indication that Guaranty drastically changed its valuation model after CWl's email. Thus, the email is relevant to scienter.
. The SAC does not plead with particularity the dates of the ALCO meetings or the substance of the conversations, alleging only that they began in the fourth quarter of 2007 and continued into 2008. Therefore, we do not draw any inferences from this allegation.
. Defendants propose a more difficult standard for pleading scienter related to accounting estimates. They suggest that plaintiffs must plead the opinions were both (1) false and (2) not honestly believed by the defendant when made, a standard adopted by the Second and Ninth Circuits. See Fait v. Regions Fin. Corp.,
. It is doubtful that Guaranty, as an investor in MBS, was even provided ongoing updates on the performance of each loan within the securities such that it could have engaged in a loan-by-loan valuation.
. We may consider these documents in our review'because the SAC refers to them and they are in the record. See Tellabs,
. We do not foreclose the possibility of finding a strong inference of scienter based on a GAAP violation in future cases should the totality of the allegations warrant such a finding.
. Dubuque, alone among defendants, presents a potential mitigating factor against inferring scienter. In August 2008, he purchased over $700,000 worth of Guaranty shares. According to Dubuque, the purchase of Guaranty stock during the Class Period "suggest[s] the absence of any nefarious motives.” Plumbers & Steamfitters Local 773 Pension Fund v. Canadian Imperial Bank of Commerce,
. Plaintiffs do not plead with particularity when Jastrow made this comment, only alleging that it occurred "before the Spin-Off.”